The evolution of EU business cycle synchronisation 1981-2007

TL;DR

This paper uses random matrix theory to analyze the evolution of business cycle synchronization among EU economies from 1981 to 2007, revealing varying degrees of correlation and differences between core EU countries, the UK, and the US.

Contribution

It applies random matrix theory to macroeconomic data to assess business cycle synchronization over time, providing a novel methodological approach.

Findings

Core EU economies showed strong, varying synchronization.

UK and US are more synchronized with each other than with EU core economies.

Synchronization levels changed over the studied period.

Abstract

Most of the analytical techniques used in the business cycle synchronisation literature rely upon the estimation of an empirical correlation matrix of time series data of macroeconomic aggregates, real GDP usually being the key variable. But the small number of available observations and small number of economies mean that the empirical correlation matrix may contain considerable noise. Random matrix theory was developed in physics to overcome this problem. The largest eigenvalue of the correlation matrix informs us directly about the degree to which movements of the economies are genuinely correlated. The evolution of business cycle synchronisation can be analysed with the temporal evolution of the largest eigenvalue over a fixed window of data. I analyse quarterly real GDP data 1981Q1-2008Q1 for the core EU economies - Germany, France, Italy, Spain, Netherlands, Belgium - along with the UK, which is a member of the EU but not the Euro, and the US as a comparator. The core EU economies have shown varying but strong synchronisation over the whole period. In contrast, the UK and the US are much more synchronised with each other than they are with the core EU economies.